Ford 2004 Annual Report Download - page 55

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Ford Credit’s interest rate risk management objective is to maximize its financing margin while limiting fluctuations caused by
changes in interest rates. Ford Credit achieves this objective by setting an established risk tolerance range and staying within this
tolerance range through an interest rate risk management program that includes entering into derivatives commonly known as
interest rate swaps.
On a monthly basis, Ford Credit determines the sensitivity of the economic value of its portfolio of interest rate-sensitive assets
and liabilities (its economic value) to hypothetical changes in interest rates. Economic value is a measure of the present value
of all future expected cash flows, discounted by market interest rates, and is equal to the present value of interest rate-sensitive
assets minus the present value of interest rate-sensitive liabilities. Ford Credit then enters into interest rate swaps, effectively
converting portions of its floating-rate debt to fixed or its fixed-rate debt to floating, to ensure that the sensitivity of its economic
value falls within an established target range. Ford Credit also monitors the sensitivity of its earnings to interest rates using pre-tax
net interest income simulation techniques. These simulations calculate the projected pre-tax net interest income of its portfolio of
interest rate-sensitive assets and liabilities under various interest rate scenarios, including both parallel and non-parallel shifts in
the yield curve. These quantifications of interest rate risk are reported to the Treasurer each month.
The process described above is used to measure and manage the interest rate risk of Ford Credit’s operations in the United States,
Canada and the United Kingdom, which together represented approximately 80% of its total on-balance sheet finance receivables
at December 31, 2004. For its other international affiliates, Ford Credit uses a technique commonly referred to as “gap analysis,”
to measure re-pricing mismatch. This process uses re-pricing schedules, which group assets, debt, and swaps into discrete time
bands based on their re-pricing characteristics. Under this process, Ford Credit enters into interest rate swaps, which effectively
change the re-pricing profile of its debt, to ensure that any re-pricing mismatch (between assets and liabilities) existing in a
particular time band falls within an established tolerance.
As a result of its interest rate risk management process, including derivatives, Ford Credit’s debt re-prices faster than its assets.
Other things being equal, this means that during a period of rising interest rates, the interest rates paid on Ford Credit’s debt
will increase more rapidly than the interest rates earned on its assets, thereby initially reducing Ford Credit’s pre-tax net interest
income. Correspondingly, during a period of falling interest rates, Ford Credit’s pre-tax net interest income would be expected to
initially increase. To provide a quantitative measure of the sensitivity of its pre-tax net interest income to changes in interest rates,
Ford Credit uses interest rate scenarios that assume a hypothetical, instantaneous increase or decrease in interest rates of one
percentage point across all maturities (a “parallel shift”), as well as a base case that assumes that interest rates remain constant
at existing levels. The differences between these scenarios and the base case over a twelve-month period represent an estimate of
the sensitivity of Ford Credit’s pre-tax net interest income. The sensitivity as of year-end 2004 and 2003 was as follows:
Based on assumptions included in the analysis, sensitivity to a one percentage point instantaneous change in interest rates
was lower at year-end 2004 than at year-end 2003. This change primarily reflects the results of normal fluctuations within
the approved tolerances of risk management strategy. While the sensitivity analysis presented is Ford Credit’s best estimate of
the impacts of specified assumed interest rate scenarios, the model Ford Credit uses for this analysis is heavily dependent on
assumptions, so that actual results could differ from those projected. Embedded in the model Ford Credit uses are assumptions
regarding the reinvestment of maturing asset principal, refinancing of maturing debt, and predicted repayment of retail
installment sale and lease contracts ahead of contractual maturity. Ford Credit’s repayment projections of retail installment sale
and lease contracts ahead of contractual maturity are based on historical experience. If interest rates or other factors were to
change, the actual prepayment experience could be different than projected.
Additionally, interest rate changes of one percentage point or more are rarely instantaneous or parallel, and rates could move
more or less than the one percentage point assumed in Ford Credit’s analysis. As a result, the actual impact to pre-tax net interest
income could be higher or lower than the results detailed above. The model used to conduct this analysis also relies heavily on
assumptions regarding the reinvestment of maturing asset principal, refinancing of maturing debt, and predicted repayment of
sale and lease contracts ahead of contractual maturity.
The fair value of Ford Credit’s net derivative financial instruments (derivative assets less derivative liabilities) as reported in Note
19 of the Notes to the Financial Statements as of December 31, 2004 was $6.0 billion. This was approximately $2.5 billion
lower than a year ago. This decrease primarily reflects the maturity of swaps that were significantly in the money and lower
mark-to-market adjustments resulting from interest rate changes. Increases related to the continued strengthening of foreign
currencies relative to the U.S. dollar were a partial offset. For additional information on Ford Credit derivatives, please refer to
the “Financial Services Sector” of Note 19 of the Notes to the Financial Statements.
Pre-tax Net Interest Income impact given
a one percentage point instantaneous
increase in interest rates (in millions)
Pre-tax Net Interest Income impact given
a one percentage point instantaneous
decrease in interest rates (in millions)
December 31, 2004 $( 93) $ 93
December 31, 2003 (179) 179
5 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK